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Gold: Stage One Or Two

By: Douglas V. Gnazzo | Thursday, October 27, 2005

Introduction

Gold has recently rallied to a new high of $475.50 an ounce per the London
Fix. The price action has induced speculation as to whether gold is in stage
one or two of its bull market. Obviously, one's definition of stage one or
two has a lot to do with the determination.

Some pundits say yes, others say no. The parameters vary widely: from comparisons
to past bull markets, to wave counts, to sentiment readings, to fundamental
analysis as to exactly what makes a bull market in gold occur.

If we had to choose one or the other, we would say - no, with the caveat that
we may be in the very beginning of stage two. However, one cannot be certain
without the forgiveness afforded by hindsight - at least according to the reasons
we have read so far.

The above are not excuses or hedges, just the plain truth that no one can
predict the future with any degree of certainty or precision, nor is such prediction
needed.

We will explain the reasons why we do not believe that stage two has yet to
begin, although it may very well be in the transition of so doing.

We will also explain why one doesn't need to predict the future for successful
investing. All that is required is to be able to recognize the proper opportunity
when it presents itself - as it is occurring - not ipso facto, not beforehand,
but during.

The Golden Key

The key to a gold bull market is same as the key to any bull market - the
demand of investors for the investment under consideration.

In the case of a gold bull, it is the demand for gold. As with any market
or commodity, buyers have to be willing to pay a higher price, as compared
to what sellers are willing to accept as a lower price.

It's the age-old battle between buyers and sellers. If buyers predominate,
it's a bull. If sellers predominate, it's a bear.

Gold is the ultimate form of money, providing historical evidence and a proven
track record dating back thousands of years. It is important to remember that
gold is priced in the reserve currency of the world - U.S. Dollar bills, a.k.a.
Federal Reserve Notes.

Also of note is the fact that the U.S. dollar is paper fiat money - just as all
other currencies are. It has been pointed in out in the media that one
of the initial reasons that gold goes up is because the currency it is priced
in (U.S. dollars) is experiencing devaluation.

In other words, the purchasing power of the U.S. dollar is falling, causing
more units of money (quantity) or a higher price, needed to buy gold. This
is also known as currency debasement, a.k.a. inflation.

However, there is not a one-to-one causal ratio between currency devaluation
and the increase in the price of gold as denominated in that same currency.

For example, the price of gold in U.S. dollar bills has increased from a low
of $257 in 2001, to a recent high of $475.50 in 2005. This represents an increase
of approximately 86%.

During the same 4-year span of time (2001-2005), the U.S. dollar has fallen
approximately 33%. This means the price of gold has gone up 2.6 times more
compared to the rate the dollar has gone down. Clearly there is more involved
then just the existing devaluation of the reserve currency.

Expectations And Fundamentals

What are involved are the expectations of investors regarding future
debasement and loss of purchasing power of the U.S. currency. Markets look
ahead to try and discern what is coming - not what has already passed.

It has been said that if the gold bull is for real it is because of its own
fundamental reasons and not merely due to the U.S. dollar bear market. So the
question naturally arises - what are the fundamental reasons?

Gold is the ultimate form of money; it has been for thousands of years. Why?
- Because gold retains its purchasing power better than any form of
paper fiat money.

Since 1913, the U.S. dollar has lost 95% of its purchasing power. Total U.S.
debt has soared during this same period. Wealth is not determined by the quantity
of money that one has, but by the quality (purchasing power) of the money.
The quality (purchasing power) is what is of value, the value that money has
to be used to exchange for all goods.

Gold is the Sovereign of Sovereigns. Gold is the best store of wealth. This
is why gold is in demand - to provide protection from not only past currency
devaluation, but also from anticipated future loss of purchasing power
as well.

All world currencies are paper fiat currencies; and as such, they are all
subject to devaluation and loss of purchasing power.

Because the U.S. dollar is the reserve currency of the world, all other fiat
currencies are based in pyramid fashion upon the dollar; resulting in an increased
demand for the dollar, and a subsequent increase in supply.

Price inflation has not occurred to any great "reported" degree within
the United States due to the fact that the U.S. has exported most of its inflation
to other foreign countries.

Foreign currencies that are pyramid on top of the dollar seek out a market
large enough to accept their massive flows of supply: viz. the U.S. bond/debt
market. This causes asset inflation in the U.S. bond and real estate markets
- the Greenspan put if you will.

As we enter stage two of the bull market, it is true that gold will be rising
against most major world currencies. The primary reason will be that investor's
demand for gold will have risen - worldwide.

The Driver

The driver of the demand is not only the present loss of purchasing
power of their respective currency, but more importantly - the future expected
losses as well.

Recall that a dollar bill is not a dollar. The dollar of the Constitution
and the Coinage
Act, 1792 (The Mint Act) is a weight of silver: 371.25 grains of pure silver
- the Silver Dollar.

All paper fiat money is debasing and losing purchasing power - it can be no
other way, such is the way of fiat. Paper fiat debt-money has a built-in self-destruct
mechanism.

All foreign currencies have an exchange rate with the U.S. dollar bill. The
exchange rate can be widening or narrowing, as in increasing or decreasing.
Not only is there an exchange rate between currencies, there is also a rate
of change regarding the exchange rates.

They are two different ratio's, representing two different entities. One represents
the rate of exchange; the other represents the rate of change of the rate of
exchange.

Recall that gold is priced in U.S. dollar bills. Eventually, as all world
currencies lose value, what is important is which currencies are losing value
faster than the dollar is losing value. Loss of purchasing power is key.

Whichever currencies are losing value compared to the dollar, it will then
require more units of that currency to exchange for one U.S. dollar bill or
Federal Reserve Note.

Since gold is priced in dollars, it will take more units of the foreign currency
to first exchange for dollars, to then buy gold with. Hence, the price of gold
will be rising in that currency.

So, what is occurring, and what is most likely to increase, is a competitive
global devaluation currency game of musical chairs. All world currencies are
losing value; the $64 dollar question is: when the music stops - who will be
left standing without a chair?

In other words - he who losess the least makes out the best. In a bear market,
the one who loses the least wins.

Relativity

All paper fiat debt-money is in a bear market. All paper fiat is losing value
or purchasing power. The currency that loses the least will be performing
the best, relative to all other paper fiat currencies.

As long as gold continues to be priced in U.S. Federal Reserve Notes (dollar
bills), whichever currency loses the least in comparison to the U.S. currency,
that currency will have the lowest appreciation in terms of the price of gold.

The currency that loses the most in comparison to the U.S. currency will
have the highest appreciation in terms of the price of gold.

This is why the price of gold in the Australian Dollar and the South African
Rand have been under performing compared to other currencies, as both currencies
have been appreciating compared to the U.S. dollar. The same is true of the
Canadian Dollar, but to a lesser extent.

Gold is the money par excellence. Gold is the supreme store of wealth. Gold
is the ultimate store of value. Gold retains its purchasing power throughout
the ages. Gold is the Sovereign of Sovereigns. These are the reasons the demand
for gold is increasing.

Paper is nothing compared to gold - never has been - never will be.

So, what is the ultimate driver of all investors worldwide for gold? It is
the same as that for U.S. investors - the loss of the purchasing power of paper
fiat currency.

Because gold is priced in U.S. dollar bills, gold cannot decouple from the
U.S. currency.

All fiat currencies must first be exchanged for U.S. currency before buying
gold.

As explained above: the currency that performs the best against the dollar
actually performs the least compared to gold, viz. the Australian Dollar and
The SA Rand.

To say that a bull market in gold is occurring in other currencies means that
the value of these currencies is falling compared to the U.S. dollar; and that
all of them, including the U.S. currency, are losing purchasing power compared
to gold as money; some more than others - some less.

Price Fixing Scheme

Recall that the U.S. currency is the reserve currency of the world and that
gold is priced in dollars. All other currencies must first be exchanged for
U.S. currency before gold is purchased. The reserve currency/gold
price fixing scheme masks or lessens the true nature of what is occurring:

Global currency debasement on a massive scale: loss of purchasing power
and wealth of unprecedented proportions.

In paper fiat land, what matters the most is whether the U.S. currency is
losing purchasing power faster or slower compared to other currencies.

All currencies are losing purchasing power compared to gold, but the fact
that the U.S. currency is the reserve currency of the world confuses and compounds
the issue, which it is meant to do.

It is true that stage two of the gold bull will be powered by an increased
demand for gold.

The increased demand will be driven by the expected future loss of
purchasing power of any given currency relative to the purchasing power
of the U.S. currency, as long as gold is priced in U.S. Federal Reserve Notes.

Price Action

What other markers or indicators might there be that gold is entering stage
two of its bull market? Well, when all is said and done, what matters the most
is price action. So, let's look at a chart of the price action of gold
to see what it is saying.

The chart below is the price of gold from 1985 to 2005. Notice to the far
left of the chart the highest price, which was back in January of 1988, at
approximately $500 per ounce.

Now look to the far right of the chart. You can see the price is approaching
the $500 level again for the first time in twenty years.

Chart Courtesy of Kitco

Stand back if you will, and take the entire chart/picture in at one time.
What does the formation of the entire chart look similar to?

It starts out high on the left, travels down, bottoms out, and then moves
sideways, and finally up - approaching nearly the same height as on the left.

This is called a cup formation. One of the most powerful chart formations
is known as a cup with a handle. The handle is usually sideways action to the
right of the chart (present price action) just before the price breaks out
above the rim of the cup - the highest level reached on the chart, i.e. $500
per ounce.

From this long-term chart, it is obvious that the price level of $500 is important
if the gold bull is to stay intact. When the price breaks through this level,
stage two will definitely be starting.

When $500 becomes support rather than resistance - stage two will be here.

The Price Level

Below is a chart of gold from 1975 to 2005. Notice the spike high up to $800
per ounce on the left hand side of the chart. Follow the price action down
to the first bottom near $300 per ounce. Note where gold then rallied to -
$500 per ounce.

From here, it then fell back to the $300 level. It then rallied back up to
the same $500 price level. For the next 18 years, the price has never risen
back to the $500 level - until now, as we are getting closer by the day.

Chart Courtesy of Kitco

This is why the $500 level is of significance. Once this level is breached
and becomes support - stage two is here. Make no doubt about it.

We may very well be on the verge of breaking into stage two - a transition
appears most likely from stage one to stage two. However, that doesn't mean
that the coast is all clear, and that an intermediate term correction cannot
still take hold of the ship.

Markets do not just move in one direction - even powerful bull markets. There
is ebb and a flow to the markets, between buyers and sellers, as that's what
makes a market - differences of opinion. All moves get corrected, in either
direction, sooner or later.

Perhaps we are in stage two - perhaps not. Time will tell as it always does.
If you want to know for sure that stage two is occurring, the crossing of the
$500 level and the change from that level being resistance to support - will
undoubtedly indicate stage two.

Two things are certain: all paper fiat ends with its own
self-destruction
Gold always withstands the test of time.

Douglas V. Gnazzo is the retired CEO of New England Renovation
LLC, a historical restoration contractor that specialized in the restoration
of older buildings and vintage historic landmarks. Mr. Gnazzo writes for numerous
websites, and his work appears both here and abroad. Just recently, he was
honored by being chosen as a Foundation Scholar for the Foundation of Monetary
Education (FAME).

Disclaimer: The contents of this article represent
the opinions of Douglas V. Gnazzo. Nothing contained herein is intended as
investment advice or recommendations for specific investment decisions, and
you should not rely on it as such. Douglas V. Gnazzo is not a registered investment
advisor. Information and analysis above are derived from sources and using
methods believed to be reliable, but Douglas. V. Gnazzo cannot accept responsibility
for any trading losses you may incur as a result of your reliance on this analysis
and will not be held liable for the consequence of reliance upon any opinion
or statement contained herein or any omission. Individuals should consult with
their broker and personal financial advisors before engaging in any trading
activities. Do your own due diligence regarding personal investment decisions.
This article may contain information that is confidential and/or protected
by law. The purpose of this article is intended to be used as an educational
discussion of the issues involved. Douglas V. Gnazzo is not a lawyer or a legal
scholar. Information and analysis derived from the quoted sources are believed
to be reliable and are offered in good faith. Only a highly trained and certified
and registered legal professional should be regarded as an authority on the
issues involved; and all those seeking such an authoritative opinion should
do their own due diligence and seek out the advice of a legal professional.
Lastly, Douglas V. Gnazzo believes that The United States of America is the
greatest country on Earth, but that it can yet become greater. This article
is written to help facilitate that greater becoming. God Bless America.